DST Calculator Case Study: How Lili's Replacement Property Choice Could Cost Her $1,000,000

This is Part 2 in our calculator case study series. In Part 1, Leo was convinced he could take $5M out of his exchange, invest it at 9%, and come out ahead. The calculators showed he’d be $1.65 million behind. Here, we tackle a different question: what happens when the replacement property choice itself becomes the biggest tax decision.

In our last case study, we used Exchange Planning Corporation’s calculators to show Leo what would happen if he took $5 million out of his exchange and invested it at a higher return. He was convinced he could beat a 4.5% DST with a 9% taxable investment. The calculators showed he’d be $1.65 million behind — still in a very deep hole after 14 years.

Leo’s question was about how much to keep out of the exchange. Lili’s question is different. She’s exchanging everything. Her question is what to buy on the other side — and that decision has tax consequences that most investors never see coming.

Lili’s Situation

Lili inherited several properties in 2019. She’s decided to sell one of them for $10,000,000 and her financial advisor is already building a replacement property strategy.

The plan: put $5,000,000 into a leveraged multi-family property and the other $5,000,000 into a debt-free commercial property.

Diversified. Balanced. And potentially very expensive.

The $180,000-per-Year Problem

At Exchange Planning Corporation, we don’t make investment decisions. But we can show you — down to the dollar — what those decisions will cost in taxes.

When we ran Lili’s numbers through our calculators, the debt-free commercial property would generate roughly $180,000 per year in income taxes.

If she put that same $5,000,000 into a leveraged multi-family instead, she wouldn’t just eliminate that $180,000. She’d pick up an additional $40,000 per year in tax savings that offsets her other rental income.

In five years, that’s over $1,000,000 in tax savings — gone — because of a replacement property decision that nobody ran the numbers on.

Why Lili’s Situation Hits So Hard

This is where Lili’s case gets interesting — and where the calculators really earn their keep.

Lili lives in New York. She has nearly $1,000,000 in other rental income every year from her inherited portfolio. She already owns several commercial properties without debt. And she’s in one of the highest combined tax brackets in the country.

Now, I want to point out: if Lili lived in Texas instead of New York, had no other income besides Social Security, and was exchanging a property worth $1,000,000 instead of $10,000,000 — taxes probably wouldn’t be an issue. The numbers just wouldn’t move the needle. Context matters enormously, and the calculators show that instantly.

But in Lili’s case, every dollar of unshielded income gets hit at the top rates. A debt-free property that doesn’t generate depreciation is the worst possible fit for her tax profile.

The Full Picture: Exchange Savings vs. Future Savings

Here’s the part that ties back to what we showed with Leo — and what most people in the exchange industry still miss.

Exchanging instead of selling will save Lili approximately $2,000,000 in taxes on the gain. That’s significant. But it’s only half the picture.

Lili is relatively young. She inherited these properties only seven years ago, so there’s still basis. Buying tax-efficient replacement properties — leveraged multi-family with depreciation and cost segregation — will save her about $1,500,000 over the next five years in future income taxes.

Over her lifetime, Lili will save far more on future income than what the exchange itself saves her in capital gains taxes. No one knows what taxes will do over Lili’s lifetime, but this exchange has the potential to save her a total of almost $5M in taxes if done in the most tax-efficient manner.

With Leo, we showed that taking boot and chasing a higher return doesn’t work the way most investors expect. With Lili, we’re showing something different: the replacement property decision is a tax decision, not just an investment decision — and the future savings are bigger than the exchange savings.

What Lili Deserves to Know

Maybe Lili wants the debt-free commercial building for reasons that have nothing to do with taxes. That’s fine — it’s her money. But she deserves to see the full picture before she makes that choice.

Lili is entering a 1031 exchange for the sole purpose of saving taxes. That is the only reason 1031 exchanges exist. Their entire purpose is tax deferral. If the replacement property strategy undermines that purpose, someone should be showing her the numbers.

Helping investors like Lili understand the future tax consequences of their exchange — not just the immediate deferral — is a big part of what we do at Exchange Planning Corporation.

See the Calculators in Action

If you work with 1031 exchange investors at any level — as a financial advisor, QI, DST sponsor, or real estate professional — you owe it to your clients to show them their choices. Not just property types. Not just yields. Their choices concerning how much they’ll pay in taxes for years to come.

Register for our next calculator webinar to see how these tools work — and how they could have changed the conversation for both Leo and Lili.